High Yield Bonds Surging Anew, Up 0.9% In Past Week

By

Michael Aneiro

Aug. 20, 2014 12:27 p.m. ET

Text Size

Regular

Medium

Large

It's a been a characteristic of post-crisis, Fed, fueled financial markets that bull runs endure and corrections are fleeting. Such is the case for high yield bonds. After a pretty serious pullback in late July that saw a record $7.1 billion withdrawal from high-yield funds in a single week, that market is chugging right along once again. Fund inflows have resumed and a benchmark Bank of America Merrill Lynch index is up 0.87% in the past week alone and 1.23% so far this month. The average junk-bond yield has retreated to 5.34%, and the average spread over Treasuries is below 4 percentage points again at 3.85. The market's 2014 year-to-date return has climbed back up to 5.53%.

What caused the pullback, and whether it was warranted, is still up for debate, but I'd argued repeatedly in this blog and my weekly Current Yield column that the market was overvalued and illiquid and vulnerable heading into July. Barclays strategists point out today that three negative shocks have hit global markets this summer: higher front-end US yields, weaker euro area growth, and an escalation of geopolitical risks. "These have led to a downdraft in risky assets and a rally in major fixed income markets that accelerated in late July," Barclays writes. "Some of these moves are justified, in our view, but in other cases these shocks have created market dislocations that are worth exploiting."

Ned Davis Research strategist Joseph Kalish and economist Veneta Dimitrova today ech the argument that the selloff was a liquidity problem rather than a credit problem. They point out that only a little over half of the sharp rise in high-yield spreads seen late last month was due to increased credit risk, with the rest due to other factors, specifically liquidity.

"[C]redit risk remains historically low," Kalish and Dimitrova write. "As long as that's the case, we will remain overweight credit risk and use corrections to add to those positions."

The trick, of course, is recognizing these corrections and acting quickly enough to take advantage of them. As the high-yield market's August performance shows, things get back to normal very quickly, and normal these days means a seemingly endless and effortless bull run.

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.